Completion Report - Asian Development Bank€¦ · Completion Report . Program Number: 41108 . Loan Number: 2340 . November 2012 . Pakistan: Second Generation of Capital Market Reform

Completion Report

Program Number: 41108 Loan Number: 2340 November 2012

Pakistan: Second Generation of Capital Market Reform Program

CURRENCY EQUIVALENTS

Currency Unit – Pakistan rupee/s (PRe/PRs)

At Appraisal At Program Completion 30 June 2007 30 September 2012

PRe1.00 = $0.017 $0.011 $1.00 = PRs60.37 PRs94.80

ABBREVIATIONS

ADB – Asian Development Bank DMF – design and monitoring framework FMGP – Financial (Nonbank) Markets and Governance Program FSCP – Financial Services Commission of Pakistan FY – fiscal year GDP – gross domestic product ICM – Institute for Capital Markets IMF – International Monetary Fund LIBOR – London interbank offered rate MOF – Ministry of Finance NBFC – nonbank financial companies NIT – National Investment Trust NSS – National Savings Scheme SBP – State Bank of Pakistan SECP – Securities and Exchange Commission of Pakistan TA – technical assistance VPS – voluntary private pension scheme

NOTES

(i) The fiscal year (FY) of the government ends on 30 June. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2012 ends on 30 June 2012.

(ii) In this report, "$" refers to US dollars.

Vice-President X. Zhao, Operations 1 Director General K. Gerhaeusser, Central and West Asia Department (CWRD) Director B. Wilkinson, Public Management, Financial Sector, and Trade

Division, CWRD Team leader J. Conrad, Senior Financial Sector Specialist, CWRD Team member S. Ali, Senior Project Officer, CWRD

F. Teves, Project Analyst, CWRD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page BASIC DATA i

I. PROGRAM DESCRIPTION 1

II. EVALUATION OF DESIGN AND IMPLEMENTATION 1 A. Relevance of Design and Formulation 1 B. Program Outputs 4 C. Program Costs 10 D. Disbursements 10 E. Program Schedule 10 F. Implementation Arrangements 10 G. Conditions and Covenants 11 H. Related Technical Assistance 11 I. Performance of the Borrower and the Executing Agency 12 J. Performance of the Asian Development Bank 12

III. EVALUATION OF PERFORMANCE 12 A. Relevance 12 B. Effectiveness in Achieving Outcome 12 C. Efficiency in Achieving Outcome and Outputs 13 D. Preliminary Assessment of Sustainability 13 E. Impact 14

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 14 A. Overall Assessment 14 B. Lessons 14 C. Recommendations 14

APPENDIXES

1. DESIGN AND MONITORING FRAMEWORK 16

2. PAKISTAN: FINANCIAL SECTOR INDICATORS 21

3. POLICY MATRIX FOR THE SECOND GENERATION OF CAPITAL MARKET REFORM PROGRAM 23

BASIC DATA

A. Loan Identification 1. Country 2. Loan Number 3. Program Title 4. Borrower 5. Executing Agency

6. Amount of Loan 7. Program Completion Report Number

Pakistan 2340 Second Generation of Capital Market Reform Program Islamic Republic of Pakistan Ministry of Finance $400 million from the ordinary capital resources of ADB under ADB’s London interbank offered rate (LIBOR)-based lending facility PCR: PAK 1377

B. Loan Data 1. Appraisal – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Loan Agreement

5. Date of Loan Effectiveness – In Loan Agreement – Actual – Number of Extensions

6. Closing Date – In Loan Agreement – Actual – Number of Extensions

7. Terms of Loan – Interest Rate

– Maturity (number of years) – Grace Period (number of years)

24 April 2007 2 May 2007 18 June 2007 21 June 2007 31 July 2007 15 May 2008 14 June 2008 13 June 2008 none 30 June 2009 12 July 2011 two ADB’s LIBOR-based lending facility 15 years 3 years

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8. Disbursements a. Dates

Initial Disbursement

16 June 2008

Final Disbursement

30 June 2011

Time Interval

36.5 months

Effective Date

13 June 2008

Original Closing Date

30 June 2009

Time Interval

12.5 months

b. Amount ($ millon)

Category Original

Allocation

Last Revised

Allocation Amount

Canceled

Net Amount

Available Amount

Disbursed Undisbursed

Balance Second Generation of Capital Market Reform Program 400 0 0 400 400 0 Total 400 0 0 400 400 0 C. Program Data 1. Program Costs ($ million)

Cost Appraisal Estimate Actual Foreign Exchange Cost 400 400 Local Currency Cost 0 0 Total 400 400

2. Financing Plan ($ million)

Cost Appraisal Estimate Actual First tranche release 200 200 Second tranche release 200 200 Total 400 400 3. Cost Breakdown by Program Components ($ million)

Component Appraisal Estimate Actual Second Generation of Capital Market Reform Program

400 400

Total 400 400 4. Program Schedule

Item Appraisal Estimate Actual First tranche release after loan effectiveness 16 June 2008 Second tranche release between 6 and 18 months after release of the first tranche 30 June 2011

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5. Program Performance Report Ratingsa

Ratings Implementation Period Development Objectives Implementation Progress

From 31 July 2007 to 28 February 2008 Satisfactory Satisfactory From 29 February 2008 to 30 May 2008 Satisfactory Unsatisfactory From 31 May 2008 to 29 June 2008 Satisfactory Satisfactory From 30 June 2008 to 30 August 2008 Satisfactory Partly Satisfactory From 31 August 2008 to 29 June 2009 Satisfactory Satisfactory From 30 June 2009 to 31 December 2010 Satisfactory Partly Satisfactory a Due to a systemic change in performance monitoring, no ratings are available for program loans from 2011 onwards.

D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-

Days Specialization of

Membersa, b

Loan reconnaissance 14–24 January 2007 3 33 a, b, c Loan fact-finding 6–19 March 2007 3 42 a, d, e Loan appraisal 24 April–2 May 2007 2 18 a, d Loan negotiations 18–21 June 2007 3 12 a, d, e Loan review mission 1 16 February 2009 1 1 f Loan review mission 2 25 March 2009 1 1 f Loan review mission 3 24 August 2009 1 1 f Program completion review 10–14 September 2012 1 5 g

a a = senior economist, b = project officer, c = capital market development expert, d = senior counsel, e = economist, f = principal financial sector specialist, g = senior financial sector specialist.

b The Pakistan Resident Mission provided support to the missions in the field. .

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I. PROGRAM DESCRIPTION

1. In July 2007 the Asian Development Bank (ADB) approved the Second Generation of Capital Market Reform Program and an accompanying technical assistance (TA) grant.1

The program aimed to enhance economic growth through a more efficient and better balanced financial system. The expected outcomes were increased resource mobilization through the capital market for productive investment and employment generation, and increased resilience of the corporate and financial sector to shocks through diversification of financial services away from banking.

2. To achieve its objectives, the program aimed to (i) strengthen the enabling environment for private pension funds and other institutional investors; (ii) address policy and regulatory constraints to the development of corporate bond markets; (iii) increase the breadth of the equity market and reduce its volatility; (vi) strengthen the institutional framework for sector supervision by transforming the Securities and Exchange Commission of Pakistan (SECP) into the Financial Services Commission of Pakistan (FSCP) for the regulation and supervision of nonbank financial institutions and services; and (v) strengthen the governance of securities markets, market professionals, and public issuers. 3. The program rationale rested on the assumption that well-functioning equity and long-term debt (bonds) markets generate substantial benefits. They facilitate the mobilization of financial resources and their efficient allocation into productive investments by providing efficient savings vehicles for retail and institutional investors and diversifying funding sources for enterprises. Diversification also makes the corporate and financial sectors more robust to shocks, enabling economic development to be more sustainable.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

4. At the time of appraisal in 2007, the program design was highly relevant. Since 1998, when a year-long economic and financial crisis had culminated in a breakdown of domestic capital markets, Pakistan had made substantial progress with financial sector reforms. The enabling legal, regulatory, and institutional framework for capital markets had been strengthened with ADB support; the financial health of ailing financial institutions had been restored; a large number of state-owned institutions had been privatized; and competition had been invigorated. However, unlike other countries in the region, Pakistan’s capital markets did not play a significant role in financial intermediation and resource mobilization. While banking sector development was not out of touch with that of other regional economies, capital market development lagged. The government intended to improve this situation with a second round of capital market reforms. 5. The government’s Medium-Term Development Framework for 2005–2010 listed private sector growth, capital market development, and private participation in infrastructure (which requires long-term debt financing through bonds) as important goals.2

1 ADB. 2007. Report and Recommendation of the President to the Board of Directors: Proposed Program Loan and

Technical Assistance Grant to the Islamic Republic of Pakistan for the Second Generation of Capital Market Reform Program. Manila.

The program was thus fully consistent with the government’s development objectives. The program was strongly

2 Government of Pakistan, Planning Commission. 2005. Medium-Term Development Framework 2005–2010. Islamabad.

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supported by the Ministry of Finance (MOF) as the executing agency of the program, the SECP and the Ministry of Privatization as the key implementing agencies, and the State Bank of Pakistan (SBP).3

6. The program was also fully consistent with ADB’s 2006–2008 country strategy and program for Pakistan.4 It was a direct continuation of ADB support provided under the Capital Market Development Program,5 approved in 1997, and the Financial (Nonbank) Markets and Governance Program (FMGP), approved in 2002.6 The program incorporated the capital market related parts of the FMGP, which was cancelled in May 2007. 7 Thus, it did not require a preparatory TA, but was based on the outputs of prior interventions and their evaluation through independent studies,8

and the strong stakeholder relationship that had developed over the years.

7. Consultations with a large number of public and private sector stakeholders were intensified during a reconnaissance mission fielded in January 2007 and a fact-finding mission fielded in March 2007. At that stage, key reform proposals that had been formulated by various stakeholder groups were incorporated into the program. These included a working group on debt market and commercial paper, a debt capital market committee—both established by the SECP—and a task force established by the MOF to review the enabling environment for holding companies. The ownership for a second round of capital market reforms was thus strong at the time of appraisal and there was broad consensus on reforms in the public and private sector. 8. The program design was sound as measured against international good practice in capital market development.9

3 The SBP was consulted during program reconnaissance and fact-finding, and participated in loan negotiations, but

was not included as an implementing agency, because only one policy action of the program (building and sustaining a yield curve over various government securities together with the MOF) was under its control.

Good practice calls for measures to strengthen market oversight and address supply- and demand-side constraints to market development. Correspondingly, the program aimed to (i) strengthen capital market governance to improve market transparency and protect investors, (ii) improve the efficiency of securities markets to increase the supply of corporate securities and optimize the allocation of financial resources into productive investment, and (iii) support the development of institutional investors to facilitate long-term capital formation

4 ADB. 2005. Country Strategy and Program Update: Pakistan 2006–2008. Manila. 5 ADB. 1997. Report and Recommendation of the President to the Board of Directors on Proposed Loans to the

Islamic Republic of Pakistan for the Capital Market Development Program. Manila (Loan 1576-PAK and 1577-PAK[SF], approved on 6 November, for $259 million).

6 ADB. 2002. Report and Recommendation of the President to the Board of Directors on Proposed Loans and Guarantees to the Islamic Republic of Pakistan for the Nonbank Financial Markets and Governance Program. Manila.

7 The FMGP had a number of complex amendments to financial sector laws, covering an array of issues in various subsectors. The legal process had been considerably delayed and had not reached a closure in early 2007. Further, the financial sector had changed significantly since the FMGP was approved, which necessitated a reprioritization of the sector reform agenda. The government, therefore, proposed that (i) certain aspects of the reform measures under the FMGP (particularly those relating to capital market development) be pursued and strengthened under the proposed Second Generation of Capital Market Reform Program, and (ii) other aspects of the reform measures under the FMGP (such as those relating to insurance and corporate governance) be carried out more comprehensively over the course of 2008–2010 through more focused interventions.

8 ADB. 2005. Performance Evaluation Report: Capital Market Development Program in Pakistan. Manila (Loans 1576-PAK and 1577-PAK[SF]); ADB. 2005. Financial Sector Intermediation Loan in Pakistan. Manila (Loan 1371-PAK). Also compare: ADB. 2008. Special Evaluation Study: ADB Assistance for Domestic Capital Market Development. Manila. An early draft of this study was made available to the program processing team.

9 For bond markets see, for instance: Bank for International Settlement (BIS). 2005. Developing Corporate Bond Markets in Asia. (BIS Papers No 26). Basel. For equity markets see, for instance: C. Purfield, et al. 2006. Asian Equity Markets: Growth, Opportunities, and Challenges (International Monetary Fund [IMF] Working Paper WP/06/266). Washington, DC.

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Appendix 2

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and increase the demand for securities. The program also incorporated lessons learnt from previous interventions (footnote 8) by (i) focusing on two key pieces of legislation and providing TA to support the government throughout the process of legislative deliberation, (ii) generating broad ownership for the reforms, and (iii) building on achievements made under prior interventions.10

9. The program design quickly lost relevance when implementation started in conjunction with (i) a sharp deterioration of the macroeconomic situation from mid-2007 onward due to exogenous oil and food price shocks, leading, among other things, to an increase in annual inflation from 7% in mid-2007 to 22% in mid-2008 (Figure), a depreciation of the domestic currency by 22% over the same period, and plummeting official reserves; (ii) spillover from the 2008–2009 global financial crisis through various channels; (iii) domestic political turmoil; and (iv) a deterioration of the security situation. The resulting economic and political crisis undermined confidence in Pakistan’s financial institutions and markets, forced financial institutions to deleverage, and changed the political economy of the country, drawing policymakers away from structural reforms toward crisis management. The economic crisis was initially mitigated by actions taken under an International Monetary Fund (IMF)-supported stabilization program.11 However, the crisis escalated again in 2010 as a result of a major flood that devastated large parts of Pakistan and further aggravated the already difficult fiscal situation.12

The occurrence of a circular debt crisis in the energy sector, which reduced energy supply, added to the crisis. The IMF program ended in September 2011 without disbursement of the last two tranches.

10. At the time of preparation of this completion report in November 2012, the program design is gaining relevance again with early signs of revival of financial markets. The development of Pakistan’s capital markets is still part of the development strategy of the government and ADB.13

10 The specific lessons were that (i) policy actions requiring comprehensive legal reforms can hamper program

implementation, despite strong government support; (ii) strong ownership helps to ensure that reforms remain on track even under difficult circumstances; and (iii) financial sector development requires time and a series of well sequenced interventions in any environment.

11 IMF. 2008. Pakistan: Request for Stand-By Arrangement (IMF Country Report No. 08/364). Washington, DC. 12 The flood damage was estimated at $10 billion, equal to 5.8% of the gross domestic product of FY2010. 13 ADB. 2009. Pakistan: Country Partnership Strategy, 2009–2013. Manila.

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B. Program Outputs

11. Of 20 output targets included in the design and monitoring framework (DMF), 13 (65%) were met. Most of the missed targets aimed to capture increasing market activity. They were missed due to economic and political shocks (para. 9), which were mentioned as risk factors in the DMF and caused massive financial disintermediation across all subsectors of Pakistan’s financial sector. This process started in mid-2007, just after Board approval, and continued throughout the program period. During this time Pakistan’s financial sector assets plummeted from 82% of GDP in 2007—the all-time high for Pakistan—to 57.6% in 2011. An updated DMF, including achievements by 2012, is in Appendix 1. Financial sector indicators are in Appendix 2. 12. Of the 50 activities included in the DMF, 45 (90%) were undertaken despite the crisis, although 8 (16%) experienced delays of 1 year or more. These delays can be partly attributed to a failure to use the attached TA to support the government in implementing the program (para. 41). The main reason for not undertaking the remaining activities was unfavorable market conditions that prevented the privatization of state-owned enterprises. The DMF made the assumption that market conditions would allow privatization of state-owned enterprises. This did not hold true.

1. Support the Development of Institutional Investors to Facilitate Long-Term Capital Formation

a. Establish an Enabling Environment for Private Pension Funds

13. As envisioned under the program, the SECP established a regulatory framework, including prudential standards and implementation guidelines, for a voluntary private pension scheme (VPS). It authorized four financial companies to offer the VPS to their clients, and they have been doing so since 2007. The output target has thus been met. However, due to the global crisis, demand for VPS products remained weak, accumulated funds remained negligible, and the program output target was missed. This was despite the government broadening the base of eligible VPS participants from individuals with a national tax number (estimated at 1.6 million in 2006) to those with a computerized national identity card (estimated at 96 million), which includes individuals working outside the country. 14. The SECP also conducted a sample survey of 355 employer-sponsored occupational pension schemes and issued a report for stakeholder comment. Subsequently, based on the findings of the survey, the SECP drafted a legal framework for occupational pension schemes and, thereby, went beyond disclosing non-enforceable best-practice guidelines (i.e. the policy action the program called for).14

However, the 18th amendment to Pakistan’s Constitution has since moved jurisdiction for labor-related questions, including occupational pensions, to the provincial authorities. This was why the SECP has stopped monitoring occupational pensions and not sustained the respective output target. The occupational pension law could not be promulgated at the federal level for the same reason.

14 At the time of appraisal, the SECP had no legal power to regulate occupational pension schemes. However,

amendments to the 1997 SECP act enacted in fiscal year 2008 gave the SECP such power. This was reversed by the 18th amendment to the Constitution in April 2010, which realigned powers between different levels of government.

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Appendix 2

21

b. Support the Development of Domestic Institutional Investors

15. Under the program, the government made amendments to the Company Ordinance to empower the SECP to regulate mutual funds and strengthen its powers to establish prudential requirements for nonbank financial companies (NBFCs), including mutual funds. This enabled the SECP to strengthen prudential requirements by amending the 2005 rules for NBFCs. At the time of appraisal, the SECP was keen to further strengthen the legal basis for NBFC regulation and supervision. Drafting and promulgating a NBFC law was, therefore, included in the program as a monitorable condition.15 However, while the SECP drafted the law and met the relevant output target, the law was not submitted to Parliament, as it would have contradicted a condition included in ADB’s 2008 Accelerating Economic Transformation Program,16 which asked the government to transfer the jurisdiction over deposit-taking NBFCs to the SBP—the banking regulator.17

Rather than focusing on the NBFC law, the SECP thus decided to further strengthen prudential requirements for such NBFCs that remained under its jurisdiction through a by-law, adopted in 2008. That helped improve the capitalization of the NBFCs and allowed the output target to be met.

16. Due to adverse market conditions, the government failed to comply with the monitorable condition to seek cabinet approval for privatizing the remaining state shareholding in the National Investment Trust (NIT), which was by far the largest mutual fund at appraisal. The measure aimed to invigorate competition in the sector and increase the amount of assets managed by private mutual funds. 17. The failure to fully privatize the NIT and enact an NBFC law became less relevant over the program period as NBFC business opportunities declined due to the crisis.18

The program output target that captured the development of assets managed by mutual funds was met nevertheless. Furthermore, while the NIT is still the largest mutual fund investing in shares, private sector mutual funds have much larger investment in interest bearing securities and the privately owned Allied Asset Management Company has become the largest mutual fund overall. The mutual fund industry in Pakistan is, thus, on track.

15 Monitorable conditions typically capture either intermediate steps toward full compliance with tranche release

conditions or follow-up actions. 16 ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster

and Loans to the Islamic Republic of Pakistan for Subprogram 1 of the Accelerating Economic Transformation Program. Manila. The Accelerating Economic Transformation Program supported policy reforms in multiple sectors. In the financial sector, it also supported payment system reforms and anti-money laundering measures, which are both under the jurisdiction of the SBP.

17 With ADB TA, the SBP prepared draft legislation, approved by the government as a policy condition for Subprogram 1 of the Accelerating Economic Transformation Program in 2008, to designate the SBP as the lead regulator of financial conglomerates (rather than supporting the prior approach of horizontal coordination between the SEPC and the SBP) and transfer the regulation of deposit-taking NBFCs from the SECP to the SBP. The SECP was apparently not consulted about these developments before approval of the Accelerating Economic Transformation Program. In 2009, at the government’s request and after a change in SBP leadership, Subprogram 2 of the Accelerating Economic Transformation Program returned to the old concept of supporting horizontal cooperation and information sharing between the SECP and the SBP. As a result, jurisdiction for deposit-taking NBFCs remained with the SECP.

18 The NIT (together with the National Bank of Pakistan, the State Life Insurance Corporation of Pakistan, and the Employees’ Old-Age Benefits Institution) played a key role in a government initiative to stabilize equity markets in 2009 by investing in shares of selected companies. This was in response to a 2008 stock market crash.

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2. Improve the Efficiency of Securities Markets to Optimize the Allocation of Financial Resources

a. Facilitate the Development of Corporate Bond Markets

18. Under the program, the SECP established a debt capital market committee with broad stakeholder participation to identify bond market development constraints and formulate proposals to address them. The work of the committee and the dissemination of its final report helped to build reform consensus. In line with the committee’s proposals, the MOF and the SBP worked together closely to build and maintain a benchmark yield curve to include yields of treasury bills and Pakistan Investment Bonds by standardizing their terms, issuing them at regular intervals, and increasing the amounts of individual issues. These efforts were particularly successful because the MOF had a strong interest in developing the government securities market for budget deficit financing purposes and the SBP was very interested in them for monetary policy purposes. The government also started issuing tradable government bonds through the branch network of the National Savings Scheme (NSS). This provided retail investors throughout the country with a means for accumulating long-term savings through investment in higher-yielding government bonds. To provide incentives to invest in tradable instruments, the government ensured a lower rate of return for nontradable NSS instruments than for tradable bonds. 19. To increase the number of corporate bond issues and lengthen their maturity periods, the government worked with provincial authorities to reduce the cost of issuing corporate securities by lowering the stamp duties for corporate bonds. As a result, the Government of Punjab reduced stamp duty to 0.05%. This has reduced a policy distortion that discriminated against corporate bonds in favor of bank credits. The government of Singh, Khyber Pakhtunkhwa and Islamabad Capital Territory followed suit and reduced the stamp duty to 0.15%, 005%, and 0.05%, respectively, by 2010. 20. To further reduce the cost of issuing bonds, the SECP abolished the regulatory requirement for public corporate bond issues to be listed on a stock exchange and introduced shelf-registration procedures for securities; this means securities were allowed for registration for at least 1 year, during which issuers can obtain funds when market conditions are favorable. The SECP also established an enabling environment for the creation of a limited secondary market among qualified institutional buyers for privately placed corporate bonds. This aimed to increase the amount of assets available to institutional investors. Three privately placed bonds are now traded among institutional investors. 21. Despite these measures, the number of corporate bond issues declined over the program period due to adverse market conditions and the quantitative output target was missed. The target capturing increasing bond maturity was initially met, but it was not sustained.

b. Increase Equity Market Breath and Reduce its Volatility

22. As asked for under the program, the government continued the exemption from capital gains tax on income earned from individual investment in shares to facilitate long-term capital formation and increase the demand for securities. Since July 2010, capital gains are taxed, but only if the holding period is less than 1 year. To reduce the high volume of speculative short-term investment, which was seen as a problem before the start of the program, the government introduced a withholding tax of 0.01% on such investment. This is still in place.

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Appendix 2

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23. Under the program, the government introduced a more capital-market-oriented privatization approach to increase the supply of securities. Ten percent of the shares of the Oil and Gas Development Company were listed at the London Stock Exchange in December 2006. Shares of this company were also sold to individual domestic investors in January 2007. The government also sold 23.3% of the shares of the United Bank Limited at London Stock Exchange in July 2007 and made an initial public offering of 7.5% of the shares of the Habib Bank at Karachi Stock Exchange in October 2007.19

In addition, the government developed and approved a policy of supporting capital market development through the sequenced divestment of shares in state-owned companies through stock exchanges in both domestic and international markets, taking into account stock market conditions and investor demand. It thereby met the relevant output target. However, the government did not proceed with individual transactions after a stock market crash in mid-2008 (and missed the respective output target) because market conditions and investor demand did not support privatization. For the same reason, the government also did not offer shares in state-owned enterprises through shelf-registration (book building), which was allowed by the SECP under the program in 2008 to encourage institutional investment in shares. Nevertheless, five private companies used shelf-registration in 2009–2011.

3. Strengthen the Governance of Capital Markets to Improve Market Transparency and Protect Investors

a. Strengthen the Institutional Framework for Sector Supervision

24. Given the urgency of instituting suitable governance arrangements for the SECP, particularly for recruiting and retaining qualified staff and senior personnel, the government strengthened the SECP’s governance early on under the program. The SECP was allowed to move to competitive remuneration for senior officers, which helped fill vacancies as asked for under the program. All five commissioner positions were filled as of September 2012. Over the program period, the SECP also substantially strengthened the capacity of its branch office in Karachi to enable it to supervise securities markets and NBFCs more effectively. 25. Under the program, the SECP was to be converted into the FSCP in charge of regulation and supervision of NBFCs and services by clearly codifying its powers, functions, governance, and accountability in line with international good practices. This was a direct continuation of ADB’s prior work in the sector.20 To achieve this, the government was asked to draft and submit to Parliament a law codifying the FSCP. This law would establish the FSCP based on the SECP and strengthen its enforcement powers by enhancing its independence, governance, and accountability. The law was drafted by the SECP with ADB support, and submitted to the MOF as a first tranche condition. In June 2011, the draft law was approved by the Prime Minister and submitted to Parliament. The long delay in submitting the law to Parliament was due to reservations that the SBP developed after appraisal, as it intended to establish itself as the lead regulator for financial groups (footnote 17).21

19 Due to misleading evidence, the 2011 progress report included the information that only 3.26% of the shares of the

United Bank Limited were offered on the London Stock Exchange in 2007.

However, after a change in its leadership, the SBP

20 The SECP had been established under ADB’s Capital Market Development Program in 1999. Jurisdiction over insurance, private pension funds, and other NBFCs was added over time under that program and the FMGP. The framework law was designed to incorporate the SECP’s powers to administer a number of subsector-specific laws such as the laws governing securities markets and intermediaries, insurance, private pension funds, and NBFCs—i.e., companies the SECP already had jurisdiction over.

21 The approach of the program was to first simplify the mostly opaque structure of financial groups in Pakistan by facilitating the formation of holding companies, and then to use them for regulatory purposes. In the meantime, the SECP’s legal basis and capacity were to be strengthened under the program.

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supported the legal initiative again from 2009 onward and the government submitted the draft law to Parliament. As of September 2012, the FSCP law (renamed the new SECP law) is still pending in Parliament.

b. Strengthen the Governance of Securities Markets, Market Professionals, and Public Issuers

i. Financial Groups

26. The program recognized the potential use of holding companies to achieve both business and regulatory objectives, and it supported a sequenced approach to facilitating their formation.22

Under the program, the government established a task force comprising the Central Board of Revenue, the SECP, and the Pakistan Business Council to (i) review the enabling environment for holding companies with special emphasis on their taxation, (ii) undertake stakeholder consultations, and (iii) formulate proposals in line with international good practice to facilitate the formation of holding companies. Based on these proposals, the government eliminated tax policies that caused double taxation of parent and subsidiary companies in a holding company network. This has facilitated the formation of holding companies.

27. The SECP then drafted regulations on the reporting requirements of enterprises that opt for group taxation, including holding companies that own or control NBFCs. The reporting comprised (i) ownership structure and relationship of companies within the holding company group, (ii) disclosure of intercompany and related party transactions, and (iii) public disclosure of audited financial reports in accordance with international accounting standards. The regulations will be adopted under a new securities market law, which is before Parliament (para. 30) 28. Toward the end of the program, the SECP undertook a self-assessment to determine compliance with international good practice in the regulation and supervision of securities markets and private pension funds. Compliance with the principles of the International Organization of Securities Commissions was assessed by SECP with support from the United States Securities and Exchange Commission. Following the assessment, the SECP became a full member of the International Organization of Securities Commissions.

ii. Securities Law

29. To facilitate investor protection and capital formation, the government granted the SECP the power to approve or deny audit firms the authority to audit NBFCs licensed by the SECP, listed companies, and publicly tradable companies. This has strengthened the SECP’s capability to ensure quality and consistency in the financial information available to investors and the regulator. The SECP has also installed an electronic market surveillance monitoring system to strengthen the supervision of trading activities. The system became operational in April 2010. The SECP’s surveillance system complements the systems established by the stock exchanges as frontline regulators. Finally, the SECP drafted a guideline on obtaining information about unlisted publicly tradable companies, which can be adopted under the new securities market law, which is before parliament (para. 30). Stock exchanges (and the SBP) continued to provide information on listed companies on their websites. 22 At appraisal, there were about 60 groups of companies in Pakistan, few of which used a holding company

structure. Some groups included financial entities. However, given their opaque structure, it was often difficult, if not impossible, to discern the actual owners of financial entities; monitor transactions between financial institutions within the group; and enforce laws and regulations, including prudential requirements.

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Appendix 2

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30. To further strengthen investor protection, the government has drafted and submitted to Parliament a new securities market law that will replace the Securities Ordinance of 1969 and provide a sound legal framework for modern securities markets. The new law will mandate the SECP with adequate legal powers and responsibilities for the regulation and supervision of the securities markets and intermediaries, private placements, public offers of listed and unlisted securities, corporate governance practices, and related matters, in line with international good practices. The law will also introduce the concept of “best efforts” and other levels of underwriting commitment.23

The concept of underwriting has been broadened to recognize that modern capital markets demand the flexibility to offer either firm commitment underwritings or “best efforts” placements of securities. The law will also introduce a class of publicly tradable companies and require all such companies, listed and unlisted, to comply with comparable governance and disclosure requirements. This will eliminate the possibility of regulatory arbitrage and its harmful effects in the form of disincentives for listing and undermining investor protection. As of October 2012, the new securities market law is still before Parliament.

iii. Securities Institute of Pakistan

31. Under the program, the government supported a feasibility study for the creation of a certification agency, which was called the Securities Institute of Pakistan in the study but ultimately named the Institute for Capital Markets (ICM). In 2008, the ICM was established by SECP, the stock exchanges, various industry associations, and other stakeholders. The ICM aims to increase professional standards and qualifications among securities market professionals. The SECP provided financial support, as asked for under the program, and developed, together with the ICM, a certification system for professional market participants who have completed ICM training courses. Securities brokers and mutual fund sales agents dealing with public customers are now certified by examination. The number of professionals trained quickly exceeded the program output target. The SECP also required all brokerage firms to designate a compliance officer certified by examination by the ICM. As a supportive measure, the SECP published on its website a new code of conduct for brokers. This code, which complemented an first code that was annexed to the 2001 Brokers and Agents Registration Rules, became part of the ICM’s curriculum.

iv. Governance of Stock Exchanges

32. Under the program, the SECP enhanced market transparency and best execution of customer orders by requiring the stock exchanges to establish an intermarket surveillance committee. The committee has met regularly to coordinate stock market surveillance and oversight of securities. Further, stock exchanges have prepared and disclosed plans for strengthening self-regulation. The plans identified the functions to be performed by the exchanges in their capacity as self-regulatory organizations in line with international good practices. The relevant output target was met. The target to make price quotations from the Karachi Stock Exchange available on a real-time basis at stock exchanges in Islamabad and Lahore was met early under the program through the introduction of a new trading system after public consultations with brokers and customers. In August 2012, all three exchanges demutualized under the May 2012 demutualization act. As a precondition, they were required to separate commercial from regulatory functions. This should help to further strengthen the governance of stock exchanges.

23 “Best efforts” are defined as an agreement in which an underwriter promises to make a full-fledged attempt to sell

as much of an initial public offering as possible to the public. Best effort agreements are used mainly for securities with higher risk, such as unseasoned offerings, or in less-than-ideal market conditions.

10

C. Program Costs

33. ADB supported the program with a loan of $400 million from ADB’s ordinary capital resources. The loan was fully disbursed in two equal installments. The costs associated with implementing the program are not easily quantifiable, given the nature of the program. However, they were substantial, particularly since the program was implemented under politically and economically difficult circumstances. In addition, a TA grant in the amount of $1,000,000 was approved. Government financing for the TA was estimated at $340,000 equivalent. D. Disbursements

34. The proceeds of the loan were withdrawn in accordance with ADB’s standard disbursement procedures. The first tranche was released on 16 June 2008, 10.5 months after program approval, due to a delay in loan effectiveness (para. 35). The second tranche was released on 30 June 2011, 3 years after the disbursement of the first tranche, with a delay of 18 months. E. Program Schedule

35. The loan was approved on 31 July 2007 and became effective on 13 June 2008. The delay was caused by changes to the draft FSCP law, prepared as a first tranche condition (para. 25), that occurred after loan approval. These changes appeared to undermine FSCP’s independence.24 The government was able to address ADB’s concerns.25

The release of the second tranche was delayed due to the economic and political crisis that affected Pakistan over the implementation period and distracted the government from structural reforms (para. 9), like many of those included in the program. The attached TA was not used as originally planned to support program implementation (paras. 40–41), which also contributed to delays. The loan was closed on 12 July 2011 and the program completion rreview mission was fielded on 10—14 September 2012.

F. Implementation Arrangements

36. The MOF was the executing agency for the program. The SECP and the Ministry of Privatization were the implementing agencies. The government was to establish a program coordination unit in the MOF, staffed with two or three officials. ADB was to closely monitor program implementation to ensure that the envisaged outputs were achieved. In light of the scope and design of the program, which was not overly complex, these arrangements were adequate at the time of appraisal. However, the coordination unit was not properly staffed and ADB did not closely monitor program implementation, despite the challenges due to the economic and political instability. The three review missions fielded took place between February and July 2009; none of the reviews exceeded 1 day.26

24 These changes enabled senior government officials to join and even chair the policy board of the SECP, raising

concerns regarding its independence, which the program aimed to strengthen.

Furthermore, ADB did not use its online system to monitor program implementation.

25 The government revised the draft amendments to remove senior government members from the SECP’s policy board.

26 The reviews were part of multipurpose missions to Islamabad which focused on loan processing. The review missions met with the SECP, but no meetings took place with the Privatization Commission as second implementing agency of the program, the stock exchanges, or other private sector stakeholders. No mission was fielded to prepare the 2011 progress report.

11

Appendix 2

21

G. Conditions and Covenants

37. The program included 19 first tranche release conditions and 9 second tranche release conditions, which were all relevant for achieving the desired program outputs. It also included 14 monitorable conditions (footnote 15). All first tranche conditions were met by the time of loan approval. Their relatively high number ensured that important reforms were front-loaded. The June 2011 progress report to the ADB Board of Directors on the program stated that 7 second tranche conditions had been fully complied with and 2 had been partly complied with; a waiver was sought for these 2 conditions. 27 The report further stated that 8 of the monitorable conditions had been fully complied with, 3 had been partly complied with, and 3 had not been complied with. Based on additional information made available to ADB during the program completion review mission, this report assesses 1 additional tranche release condition as having been complied with.28 Further, it assesses 10 monitorable conditions as complied with, 1 as partly complied with, and 3 as not complied with.29

A detailed assessment of progress made on all program conditions is in Appendix 3.

38. The impact of partial or noncompliance with conditions on program performance is assessed as limited. Capital market performance was mainly affected by the economic and political crisis, which led to massive financial disintermediation (paras. 9, 11, and 47).30

39. ADB did not receive progress reports, including a program completion report. The void was partly filled by information supplied by the SECP on request.

H. Related Technical Assistance

40. The TA grant supporting the Second Generation of Capital Market Reform Program (footnote 1) was approved to help the government implement the reforms called for under the program. The TA was to (i) provide technical and financial support to the nascent ICM, (ii) support the elaboration of a draft NBFC law, (iii) create a regulatory framework for private pensions funds with a focus on occupational savings schemes, (iv) provide technical support and advice to the board of the privatization commission to develop a privatization road map that will provide the basis for a detailed privatization strategy, (v) support a feasibility study for privatization of state-owned enterprises identified for divestment, and (vi) disseminate the privatization strategy to the stakeholders through seminars and workshops. 41. The TA was partly used for these purposes. While support was provided to further develop the legal and regulatory framework for private pensions and support for the ICM was streamlined, 31

27 ADB. 2011. Pakistan: Second Generation of Capital Market Reform Program (Second Tranche). Manila.

no support was provided to the SECP for drafting the NBFC law and no privatization-related activities took place. Instead, the TA supported research on demutualization of stock exchanges, developed a risk management methodology for securities market participants, financed training for 25 SECP staff at the Lahore University of Management

28 The draft Financial Services Commission of Pakistan Law was submitted to parliament (policy action S.11). 29 The differences relate to conditions S.3, S.7, S.10, and S.12. 30 Three of the five conditions that were not fully met related to privatization of state-owned enterprise shares, which

was put on hold due to extremely adverse market conditions. Following through with state-owned enterprise privatization at depressed prices would not have had a positive impact on equity market performance, and instead would have had serious political repercussions and a negative effect on the budget, at least in the long term. The two remaining conditions related to NBFC legislation and reporting requirement for nonlisted public companies.

31 The TA foresaw 3.5 person-months of support from an international capital market expert and 76.0 person-months of various national experts to build up the institute. Instead, an international pension expert, fielded in 2009–2010, was asked to review the institute’s certification program and help to establish a library to provide study materials.

12

Sciences, and provided advice for accurate calculation of net asset value of illiquid long-term debt. Of the approved TA amount of $1,000,000, $716,341 were not disbursed. 42. A separate TA completion report was finalized in January 2011.32

The report states that the changes in the TA scope were minor and could be explained by changes in government priorities and difficulties in attracting international experts, partly due to the security situation. The report rates the TA partly successful and concedes that it did not fulfill its original objective. It drew the major lesson that the TA was too focused and lacked flexibility.

I. Performance of the Borrower and the Executing Agency

43. The borrower’s part in program implementation is rated partly satisfactory. The MOF as the executing agency failed to properly staff the program implementation unit (para. 36) and submit regular progress reports (para. 39). However, the efforts and persistence of the SECP in implementing the reforms supported under the program, together with its strong ownership for the reforms, merit high marks. J. Performance of the Asian Development Bank

44. ADB’s part in program implementation is rated partly satisfactory. After program approval, ADB shifted its focus from financial sector reforms supported by the SECP (and the MOF) to those supported by the SBP (paras. 15 and 25). This culminated in the approval of the Accelerating Economic Transformation Program in September 2008, which asked the government to establish the SBP as lead regulator for financial groups and move responsibility for deposit taking NBFCs from the SECP to the SBP, in contrast to the provisions of the Second Generation of Capital Market Reform Program. The SECP claims it was not properly consulted on this. Further, ADB did not actively use the attached TA to support the government in implementing the reforms under the program (paras. 40–41). Moreover, ADB did not use its own management information system to monitor program implementation and did not undertake detailed and regular in-country program reviews (para. 36).

III. EVALUATION OF PERFORMANCE

A. Relevance

45. The program design is rated relevant. It was highly relevant at appraisal, as measured against the government’s development strategy, ADB’s country strategy and program, and international good practice (paras. 4–7). It lost relevance quickly afterward due to external and domestic economic and political shocks (para. 9). Its relevance could increase again from 2013 onward with a revival of the economy and, by extension, capital market activity. Mobilizing savings for productive investment through capital markets remains high on the government’s strategic agenda. B. Effectiveness in Achieving Outcome

46. The program is rated less effective. It helped strengthen the enabling environment for capital markets by (i) establishing a regulatory environment for private pensions, (ii) strengthening the environment for NBFCs, (iii) introducing more capital market oriented

32 ADB. 2011. Technical Assistance Completion Report: Supporting Second Generation of Capital Market Reform

Program in Pakistan. Manila.

13

Appendix 2

21

privatization policies, (iv) building a benchmark yield curve for corporate bonds, (v) reducing the cost of issuing corporate bonds, (vi) making NSS instruments more market friendly, (vii) allowing shelf registration for equity and bonds, (viii) strengthening the institutional capacity of the SECP and safeguarding its independence, (ix) facilitating the formation of holding companies and strengthening their disclosure requirements, (x) improving disclosure on public companies and strengthening external audit, (xi) institutionalizing training and certification of market professionals by establishing the ICM, and (xii) strengthening the governance of stock exchanges.

47. However, due to the global financial and economic crisis and domestic economic difficulties, these achievements did not translate into increased market activity. This is why the program missed all outcome targets included in the appraised DMF, sometimes by a large margin. Economic and political shocks, mentioned in the DMF as risk factors, triggered political and economic instability, which in turn caused massive financial disintermediation and a flight into liquidity (and out of investment) across all segments of Pakistan’s financial sector. Assets of commercial banks declined from 59.6% of GDP in 2007 to 45.4% in 2011. The share of loans in bank assets declined from 52.0% to 40.7% over the same period as banks increasingly preferred investment in less risky government securities. Insurance sector assets declined from 3.5% of GDP in 2007 to 2.8% in 2011, and their share of investment in securities and properties in total assets declined from 74.1% to 25.5%. The equity and corporate bond market development indicators included in the DMF as outcome indicators reflect the same broad disintermediation trend. This trend detached the program activities and outputs from the outcome targets. In light of the scale of financial disintermediation that effected Pakistan from mid-2007, the outcome (and some output) targets should probably have been adjusted during program implementation to allow meaningful program performance monitoring. C. Efficiency in Achieving Outcome and Outputs

48. The program is rated less efficient. Program activities translated in program outputs without much TA support despite an understaffed program implementation unit, little attention by ADB to program implementation, and adverse economic and political conditions. This has resulted in an improvement in industry standards in line with best practices (para. 46). However, due to the crisis, these achievements have not yet translated into the desired outcome (para. 47). D. Preliminary Assessment of Sustainability

49. The improvements in the enabling policy, legal, regulatory, and institutional environment for capital markets in Pakistan achieved under the program (para. 46) are rated likely sustainable, given that the reforms are based on a broad stakeholder consensus. However, the FSCP law and the new securities market law are still before Parliament and need to be enacted to complete the legal and regulatory reforms envisioned under the program. Further, the SECP’s independence needs to be safeguarded against efforts to undermine it.33

The SECP’s budget and the composition of its policy board deserve particular attention.

33 Through the 2013 finance bill, the MOF has directed the SECP to remit its surplus funds to the MOF on an annual

basis. This undermines the SECP’s financial independence.

14

E. Impact

50. The program has not yet had a measurable positive impact on economic growth and financial intermediation, due to the economic and political crisis that effected Pakistan over the program period.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS

A. Overall Assessment

51. The program is rated partly successful. It was broadly implemented as conceived, although the crisis affected some program activities, particularly those related to privatization, and delayed others. The crisis also prevented policy reforms undertaken under the program from having an immediate positive impact on capital market development. Nevertheless, the program has made an important contribution to further strengthening the enabling environment for capital markets in Pakistan. This is noteworthy, because it contradicts the widespread belief that the crisis brought structural reforms to a halt in Pakistan. What is more, the improved policy, legal, regulatory, and institutional environment should provide a solid basis for capital markets to quickly recover from the crisis once its key underlying factors are resolved, and continue on the positive trajectory they followed before the crisis. Finally, the program disbursements made an important contribution to providing budget and balance of payment support to Pakistan, which helped mitigate a major macroeconomic crisis. B. Lessons

52. Capital market reforms are particularly sensitive to economic and political shocks that affect investor confidence (paras. 9 and 47). This must be taken into account when designing and implementing policy-based programs in support of capital market development. 53. With regard to financial sector oversight, the primary focus should be on regulatory objectives rather than regulatory architecture, which is a political issue. During the implementation of both the Second Generation of Capital Market Reform Program and the Accelerating Economic Transformation Program, ADB experienced difficulties because of changing views on regulatory architecture within the government (paras. 15 and 25). This should be avoided as much as possible. 54. Strengthening financial sector governance often requires promulgating new legislation, which is outside the control of the executive branch. While preparation of legislation reflects government commitment to reform, unless laws are enacted, these outputs may not bring tangible changes. ADB should support the government beyond drafting legislation in sustaining stakeholder consultations until laws are enacted (paras. 15, 25, and 30). C. Recommendations

1. Program Related

55. Future monitoring. To safeguard the SECP’s independence, ADB needs to further monitor the progress of parliamentary discussions on the new securities market law and the SECP law. The arrangements made for SECP financing and oversight, including the composition of its policy board, should also be closely monitored. Measures taken by the stock exchanges to further strengthen self-regulation after demutualization should also be closely

15

Appendix 2

21

monitored. This is required to ensure that capital market governance is strengthened, as envisioned under the program, and sustained. Further development of the NSS should also be monitored, as its instruments are apparently still, to a degree, crowding out investment in tradable government securities and corporate bonds. 56. Covenants. The privatization related program covenants should continue to be waived as long as market conditions are not conducive to state-owned enterprise privatization. However, as soon as this changes, a capital market-oriented privatization approach can (i) help increase budget revenues, since investors will tend to pay more for shares if an individual offer is embedded in a transparent and credible overall privatization strategy; (ii) support capital market development by increasing liquidity; and (iii) improve the performance of partly state-owned enterprises by infusing greater market discipline. 57. Timing of the program performance evaluation report. This should not be undertaken before Pakistan’s capital market has had time to reemerge from the deep crisis it underwent during the program period.

2. General

58. Sufficient time should be spent at the appraisal stage to assess the capacity of the executing agency and reach consensus with the government on institutional arrangements needed to successfully implement a program. ADB should then play its assigned role, for instance by implementing TA provided to support the government in program implementation. 59. ADB needs to undertake regular review missions to ensure that program implementation remains on track and necessary adjustments are made, particularly when assumptions at the design stage do not hold true and risks materialize. A crisis situation requires more (rather than less) frequent program reviews.

16 Appendix 1

DESIGN AND MONITORING FRAMEWORK Design Summary

Performance Targets/Indicators Achieved by 2012 Assumptions and Risks

Impact More sustainable economic growth through improved financial sector intermediation

Increased money supply (from 45% of GDP in 2005 to 65% in 2012) Increased savings rate (from 16% of GDP in FY2005 to 19% in FY2012) Increased financial savings (from 7.5% of GDP in FY2005 to 12% in FY2013) Increased savings mobilized by NBFC (from 0.9% in 2005 to 4% in 2013)

Unlikely to be achieved: Money supply fell to 42% in 2009 and 38% in 2011 Partly achieved: Savings rate was 17.3% of GDP in 2011 Unlikely to be achieved: Financial savings peaked at 9.1% in FY2007. They fell to 2.9% in FY2009 and have since recovered to 5.9% in FY2011 Unlikely to be achieved; NBFC savings peaked at 1.1% in FY2007, turned negative in FY2009, and recovered to 0.3% by FY2011

Assumption There is continued government commitment to financial sector reforms. Risk Endogenous or exogenous shock (political and economic) may occur.

Outcome A more efficient and more balanced financial sector

Increased stock market capitalization (from 42% of GDP in 2005 to 60% in 2009) Increased volume of outstanding corporate bonds (from 0.5% of GDP in 2005 to 3% in 2009) Increased number of companies listed at the stock market (from 652 in 2006 to 700 in 2009) Increased issuance of equity capital (from 14 issues in 2005 to 50 in 2007–2009) Increased issuance of corporate bonds (from 14 issues in 2005 to 50 during 2007–2009) Increased longest available bond maturity (from 8 years in 2006 to 12 years in 2009)

Not achieved: Capitalization fell to 21% in 2009 and 16% in 2011 Not achieved; Volume fell to 0.3% in 2009 and 0.4% in 2011 Not achieved: Number of listed companies fell to 651 in 2009 and 638 in 2011 Not achieved: Decline to 12 issues in 2007, 9 in 2008, 4 in 2009. 4 in 2011 Not achieved: Declined to 7 issues in 2007, 8 in 2008, and 3 in 2009. 2 issues in 2011 Achieved but not sustained: Increased to 10 years in 2009, but fell to 3 years in 2010 and 7 years in 2011

Assumptions Political commitment to undertake capital market reforms is maintained. Institutional capacity to undertake reforms exists.

Appendix 1 17

Appendix 2

21

Design Summary


Outputs 1. Enabling

environment for private pension funds established

2. Development

of domestic institutional investors supported

3. Corporate bond market development facilitated

4. Equity market breadth increased and volatility reduced

Financial companies offer private pension products to their customers SECP undertakes off- and on-site monitoring of occupational pension schemes (continuous) Funds accumulate under voluntary private pension schemes (up to 1% of GDP by 2009) Draft legislation on nonbank financial companies prepared (with TA support) Increasing assets managed by private mutual funds (from PRs63.3 billion in FY2005 to PRs205.0 billion in FY2008 (without NIT) Increasing paid-in capital of NBFCs Increased issuance of corporate bonds (from 14 in 2005 to 20 in 2008) Increased longest-available bond maturity (from 8 years in 2006 to 9 years in 2008)

Draft policy for sequenced sales of SOE shares through the capital market prepared (with TA support) Privatization of packages of large SOEs through the stock exchange taking place (10 additional primary and/or secondary offerings by March 2009) Public float of 10 largest listed companies increased (from 20% on average to 30% by 2009)

Achieved: Four companies offer such products Not achieved: Jurisdiction for occupational pensions moved to provincial authorities Not achieved: Still negligible due to lack of demand Achieved by 2008 Achieved: Increase to PRs249.6 billion at FY2008, decline to PRs153.8 billion at FY2009, but recovery to PRs280.6 billion at FY2012 Achieved in absolute terms Not achieved: Decline to 8 bonds issued in 2008 and 2 in 2011 Achieved (but not sustained): Increased to 10 years in 2009, declined to 3 years in 2010, and increased to 7 years in 2011 Achieved: Policy drafted and approved Not achieved: Only two additional offerings due to adverse market conditions Achieved: Public float of 10 largest listed companies

Assumption Effective coordination among relevant government agencies, including MOF, SECP, Ministry of Privatization, Privatization Commission, and State Bank of Pakistan. Assumption Overall favorable inflation and interest rate environment is maintained. Assumption Market conditions allow privatization of SOEs through stock exchanges.

18 Appendix 1

Design Summary


5. Institutional

framework for sector supervision strengthened

Declining share of 30 largest companies in overall trading (from 90% in 2006 to 80% in 2008) Financial services commission law, which substantially complies with international best practice, enacted and FSCP established FSCP established with adequate budget and qualified staff (Sep 2008) Reduced job vacancies at the level of commissioners (from 3 of 5 commissioners on average in 2006 to 2 of 7 commissioners in 2008)

increased to 22% in June 2012 Achieved: Share fell to 62% in Jan–June 2012 Not achieved: The law is pending in Parliament as of October 2012 Achieved: Budget increased substantially Achieved: All five positions (under SECP law) filled as of September 2012

Risks Passing of Financial Services Commission Law is significantly delayed. Qualified staff are lost.

6. Governance of securities markets, market professionals, and issuers strengthened

Securities law, which substantially complies with international best practice, enacted (Jun 2007) TA consultants fielded to build capacity of the SIP SIP undertakes training seminars for brokers and sales agents (300 individuals trained by Dec 2008) Stock exchanges disclose plans for self-regulation (Jun 2008) Price quotations from KSE available at ISE and LSE on a real-time basis (Mar 2009)

Not achieved: The law pending in Parliament as of October 2012 Achieved Achieved since December 2010 Achieved: KSE disclosed a plan in 2009. ISE and LSE in 2012 Achieved since December 2007

Risk Passing of securities law is significantly delayed. Assumption There is continued stakeholder support for SIP.

Activities with Milestones 1.1 Regulatory framework for voluntary pension funds adopted 1.2 At least four qualified financial companies authorized to offer pension

products 1.3 Regulatory application guidelines for voluntary pension funds adopted by

May 2007 1.4 Base of participants eligible for the voluntary pension schemes

broadened beyond individuals with a national tax number

Status

Inputs ADB: $401 million

Appendix 1 19

Appendix 2

21

Design Summary


1.5 Diagnostic assessment of employer-sponsored occupational pension scheme completed by December 2007

1.6 Requirements for establishing an enabling environment for occupational pension schemes identified by December 2007

1.7 Best practice guidelines for employer-sponsored occupational pension schemes issued by September 2008 (with TA support)

1.8 A specified number of state-owned shares offered to private pension funds by the end of the program

2.1 Cabinet Committee on Privatization approves privatization of NIT 2.2 Company Ordinance amended to provide SECP with the power to

strengthen prudential requirements for NBFCs 2.3 Financial advisor for NIT privatization appointed by September 2007 2.4 Legislation that establishes SECP (FSCP) as the sole regulatory and

supervisor for NBFCs and services drafted by December 2007 (with TA support)

2.5 Structure of NIT privatization approved by Cabinet Committee on Privatization by March 2008

2.6 Legislation that establishes SECP (FSCP) as the sole regulatory and supervisor for nonbank financial companies submitted to Parliament by June 2008

3.1 Debt capital market working group established to identify bond market development constraints and formulate proposals to address them

3.2 Initial steps taken by MOF and State Bank of Pakistan for building a benchmark yield curve for corporate bonds

3.3 Report of the debt capital market working group publicly disseminated by May 2007

3.4 Shelf registration procedures for corporate bonds allowed 3.5 Stamp duties for corporate debt reduced in line with proposals formulated

by the working group on debt management and commercial paper 3.6 Regulatory requirement for public corporate bonds to be listed abolished

by July 2007 3.7 Liquidity of the benchmark yield curve for corporate bonds increased by

increasing the amounts of individual issues by December 2007 3.8 Enabling environment for a limited secondary market among qualified

institutional buyers of privately placed corporate bonds established by March 2008

3.9 Tradable government bonds issued through national savings centers by June 2008

4.1 A package of shares of at least one large SOE sold through listing on a stock exchange in an international financial center

4.2 Exemption from capital gains tax on income earned from retail investment in shares extended

4.3 Policy for off-loading SOEs through securities exchanges developed by February 2008 (with TA support)

4.4 Strategy for off-loading SOEs through securities exchanges endorsed by government and publicly disclosed by June 2008

4.5 SOE shares offered to domestic qualified institutional buyers or shelf-

Not done

Not done

(2010)

(2010)

(2011)

20 Appendix 1

Design Summary


registration of SOE shares allowed by the end of the program 5.1 SECP moves to competitive levels of remuneration for senior officers 5.2 Task force established to review environment for holding companies 5.3 Stakeholder consultations undertaken by the task force 5.4 Proposals to facilitate formation of holding companies formulated 5.5 FSCP act drafted and submitted to government by April 2007; revised

draft submitted to government by July 2007 5.6 Distortions caused by tax policies that lead to double taxation of parent

and subsidiary companies in a holding company eliminated 5.7 SECP designate specific positions for commissioners responsible for law,

accountancy, and economic development by July 2007 5.8 Regulations on reporting requirements of holding companies adopted by

March 2008 5.9 Self-assessment of regulatory and supervisory policies undertaken by the

end of the program. 6.1 New securities law drafted 6.2 Feasibility study for an SIP completed 6.3 SECP confirms its commitment to support SIP 6.4 New code of conduct for brokers drafted and disseminated on SECP’s

website 6.5 Stock exchanges required by May 2007 to establish an intermarket

surveillance committee 6.6 New securities law submitted to Parliament by December 2007 6.7 SIP starts training securities market participants by January 2008 (with

TA support) 6.8 Certification system for professional market participants who have

completed SIP training coursed developed by March 2008 6.9 Plan for self-regulation prepared by stock exchanges by June 2008 6.10 All securities brokers and mutual fund sales agents required to be

certified by examination by September 2008 6.11 SECP guidelines on obtaining information on unlisted publicly tradable

companies issued by September 2008 6.12 SECP (FSCP) granted the power to approve or disapprove audit firms

authorized to audit NBFCs, listed companies, and publicly tradable companies by March 2009

6.13 SECP conducts public consultations hearings on stock exchange rules and practices by the end of the program

(2010)

(2009) (2009)

(2011)a (2009)

Not done

b

FSCP = Financial Services Commission of Pakistan, FY = fiscal year, GDP = gross domestic product, ISE = Islamabad Stock Exchange, KSE = Karachi Stock Exchange, LSE = Lahore Stock Exchange, MOF = Ministry of Finance, NBFC = nonbank financial company, NIT = National Investment Trust, PRs = Pakistan rupees, SECP = Securities and Exchange Commission of Pakistan, SIP = Securities Institute of Pakistan, SOE = state-owned enterprise, TA = technical assistance. a The KSI prepared the plan in 2008; the ISE and the LSE prepared plans only in 2011 for their

demutualization. b Conducted by stock exchanges under the guidance of the SECP. Source: Asian Development Bank.

Appendix 2

21

PAKISTAN: FINANCIAL SECTOR INDICATORS

Indicators 2000 2005 2007 2008 2009 2010 2011 1. Sector Outcomes

Increased financial intermediation Broad money (M2) as percent of GDP 38.6 44.9 50.6 45.3 41.8 41.3 38.0

Financial sector assets as percent of GDP 73.2 80.0 82.0 75.3 69.7 62.5 57.8 Banking sector assets as percent of GDP 47.2 56.3 59.6 54.9 51.2 48.1 45.4 Insurance sector assets as percent of GDP 2.2 3.1 3.5 3.3 3.0 3.0 2.8 Stock market capitalization as percent of GDPa 8.9 42.0 52.1 18.1 21.3 22.0 16.3 Outstanding government bonds as percent of GDPb n.a. 7.2 6.5 6.2 5.7 6.3 9.6 Outstanding corporate bonds as percent of GDP 0.1 0.5 0.3 0.4 0.3 0.3 0.4

2. Sector Outputs Soundness and stability Total capital of banks as percent of total assetsc 9.7 11.3 12.3 12.2 12.3 14.0 14.1

Return on assets (before tax) 0.3 1.9 2.2 1.2 1.2 1.3 2.1 Nonperforming bank loans as percent of gross loans 23.5 8.3 7.6 10.5 10.5 12.6 15.3 Foreign-share in bank assets as percent of totald 26.5 9.3 3.3 4.2 3.7 3.3 3.1 Total number of commercial banks 49 45 46 46 46 46 44 Total number of insurance companies 63 57 60 45 48 48 48

Efficiency Private-owned banking sector assets as percent of total 43.9 70.9 76.6 77.3 77.4 77.7 77.6

Interest rate spread (lending–deposit rate) n.a. 3.0 4.7 5.7 5.3 6.4 6.9 Money outside banks as percent of deposits 38.8 25.8 26.2 25.3 25.6 27.8 27.2 Annual stock market turnover as percent of GDP 44.6 128.8 70.2 30.7 13.7 7.3 4.8 Annual stock market turnover as percent of

capitalization 486.8 376.3 173.5 107.2 79.8 36.8 28.4 Longest available bond maturity, years 5 8 8 10 10 3 7 Population per bank branch 17,600 20,800 19,400 18,400 18,100 18,600 18,100

22 A

ppendix 2

Indicators 2000 2005 2007 2008 2009 2010 2011 Access

Credit to the private sector as percent of GDP 22.3 28.6 29.5 29.7 23.5 21.3 18.2 Population with deposit accounts as percent of total …. 17.3 15.4 15.4 15.4 15.3 16.2 Bank deposits as percent of GDP 27.7 43.6 44.4 41.2 37.6 36.7 33.0 Number of companies listed at stock exchange 762 661 658 653 651 644 638 Number of share issues 3 7 12 9 4 5 4 Number of corporate bond issues 6 14 39 49 18 13 15

3. Financial Market Indicators Exchange rate, US$ (end-of-period) 58.0 59.8 61.2 79.1 84.3 85.7 90.0

Consumer price inflation (end-of-period) 5.1 8.5 8.8 23.3 10.5 15.2 9.7 Yield of 6M treasury bill 11.0 8.2 9.3 14.0 12.1 13.4 11.7 Yield of government bond n.a. 6.4 9.9 13.8 12.2 14.2 12.4 Stock market index (KSE 100) 1,507.6 9,556.6 14,075.8 5,865.0 9,386.9 12,022.5 11,347.7

GDP = gross domestic product, KSE = Karachi Stock Exchange, n.a. = not available. a KSE. Most companies listed at the stock exchange in Islamabad and Lahore are double-listed in Karachi. b Pakistan Investment Bonds, Sukkut Bonds, and Prize Bonds. Without (short-term) Treasury bills. c Risk weighted.

d Until 2001 share in capital. Sources: International Monetary Fund, Ministry of Finance of Pakistan, Securities and Exchange Commission of Pakistan, and State

Bank of Pakistan.

Appendix 3

23

POLICY MATRIX FOR THE SECOND GENERATION OF CAPITAL MARKET REFORM PROGRAM

Objective: Facilitate resource mobilization for productive investment and employment generation and make the corporate and financial sector more robust to shocks by (i) supporting the development of institutional investors to facilitate long-term capital formation and increase the demand for corporate

securities, (ii) improving the efficiency of securities markets to increase the supply of corporate securities and optimize the allocation of financial

resources, and (iii) strengthening the governance of capital markets to improve market transparency and protect investors.

Policy Objective

First Tranche Conditions Second Tranche (Bold) and

Other Conditions to be Monitored Policy Action

Status of Compliance

Policy Action


I. Support the Development of Institutional Investors to Facilitate Long-Term Capital Formation A. Establish an enabling environment for private pension funds.

F.1. The Securities and Exchange Commission of Pakistan (SECP) to (i) adopt a regulatory framework for voluntary private pension schemes, including a licensing mechanism, “fit and proper” criteria for fund managers, and investment policy criteria; (ii) authorize at least four qualified financial companies to offer such pension schemes to the general public; and (iii) disseminate on the SECP website (a) regulatory guidelines on registration of fund managers, authorization of pension funds, appointment of trustees; and (b) draft guidelines on record keeping and

Complied with. On (i), the SECP was given the power to regulate pensions on 15 March 2003. Voluntary Pension System (VPS) rules were notified on 27 January 2005, and the tax framework for VPS was established by amending the Income Tax Ordinance through the Finance Act 2005. The SECP complemented the rules by notifying fit and proper criteria for key employees of VPS managers and investment policy criteria on 15 July 2007, and eligibility criteria for the VPS on 15 January 2007. On (ii), in January 2007 the SECP issued licenses to qualified asset management companies to offer VPS products. The companies are JS Investments Limited, Arif Habib Investment Management, Atlas Asset Management, and Al-Meezon Investment Management. On (iii) the SECP has issued on its website guidelines for registration as pension fund manager, for the authorization of

S.1. The SECP to conduct a sample survey on employer-sponsored occupational pension schemes in Pakistan and issue a report for stakeholder comments on the enabling environment for such schemes

Complied with. The survey was conducted by the SECP in FY2008 and disclosed on the SECP’s website for stakeholder comments. The SECP then incorporated the comments and disclosed a final report. The survey was based on information provided by 355 listed companies. Its purpose was to better understand the structure of existing occupational pension schemes, learn whether the regulatory framework provides an encouraging or discouraging environment, assess the asset mix and their penetration into the savings markets, and utilize data for broad policy purposes on occupational savings, social

24 A

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advertisements pension funds, and the appointment

of trustees, and draft guidelines on record keeping and advertisements.

security, and pensions. http://www.secp.gov.pk/SCD/scd_pensions.asp

S.2. The SECP to develop guidelines for voluntary employer-sponsored occupational pension schemes

Complied with. Based on amendments to the 1997 SECP act that had given the SECP legal power to regulate occupational pension schemes, the SECP drafted legislation on such schemes rather than nonenforceable guidelines. However, the 18th amendment to the Constitution of Pakistan has moved jurisdiction for labor questions (including occupational pension schemes) to the provincial authorities.

F.2. The government to broaden the base of eligible participants in voluntary private pension schemes beyond individuals with national tax numbers

Complied with. The Income Tax Ordinance (Section 2, Clause 19A) was amended through the Finance Bill 2007–2008 to make all holders of computerized national identity cards eligible to participate in the scheme. This has increased the number of eligible participants from about 1.6 million to at least 60 million.

S.3. Upon approval of the Cabinet Committee of Privatization on a case to case basis, the Privatization Commission to offer a specified portion of the state-owned enterprises (SOEs) shares offered to the general public to private pension funds registered by the SECP

Not complied with. Due to adverse market conditions, privatization was put on hold in late 2008. This prevented the government from offering a specified portion of SOE shares to private pension funds. Market conditions also forced private pension funds to de-leverage, undermining their ability to invest in securities.

http://www.secp.gov.pk/SCD/scd_pensions.asp�



Appendix 3

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Policy Action


B. Support the development of domestic institutional investors.

F.3. The government to make amendments to the Company Ordinance through the 2007 Finance Bill to (i) strengthen the SECP’s powers to establish prudential regulation, including capital requirements, for nonbank financial companies (NBFCs); and (ii) empower the SECP to regulate NBFCs’ business and activities (including mutual funds)

Complied with. Prudential regulations for NBFCs (under the NBFC rules) have been in place since January 2004 but the SECP had insufficient legal powers under the Company Ordinance to further strengthen and enforce them. The Company Ordinance (Section 282) has been amended through the Finance Bill 2007–2008 to strengthen the SECP’s powers to establish prudential regulation, including capital requirements, for NBFCs, and empower the SECP to regulate the business and activities of NBFCs, including mutual funds.

S.4. The SECP to draft and submit to the Ministry of Finance (MOF), and the MOF to submit to Parliament for approval legislation governing NBFCs and collective investment schemes (including mutual funds) that (i) establishes the SECP (FSCP) as the regulator and supervisor; and (ii) includes independent regulation-making authority (such as for issuing prudential regulation) and inspection, investigation, and enforcement powers

Not complied with. While the SECP oversaw NBFCs under the 1984 company law at the time of program appraisal and started drafting an NBFC law in FY2008 to strengthen its legal powers, as asked for under the program, a new condition included in ADB’s Accelerated Economic Transformation Program, prevented the government from further processing NBFC legislation. In line with a condition of Subprogram 1 of the Accelerated Economic Transformation Program condition, an effort was made to move regulatory responsibility for deposit-taking NBFCs from the SECP to the State Bank of Pakistan (SBP). Nevertheless, to strengthen prudential regulation of NBFIs the SECP approved a by-law on NBFCs in 2008, and revised it in 2010.

F.4. The government to initiate the privatization of National Investment Trust (NIT), the largest remaining state-owned

Complied with. The government’s Committee on Privatization has decided that NIT mutual funds management will be contracted out to the private sector through the

S.5. The Privatization Commission, with the support of a financial advisor and/or lead manager, to consider various options for

Not complied with. While the Privatization Commission explored options for NIT privatization, the cabinet

26 A

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Policy Action


mutual fund, by obtaining Cabinet Committee on Privatization approval for its privatization

Privatization Commission under the Capital Market Program of the ADB (Case No. 101/10/2000; para. 5 [d]).

structuring the privatization of the NIT and seek the approval of the Cabinet Committee on Privatization on the transaction structure

decided not to proceed with the transaction on the recommendation of potential lead managers due to adverse market conditions.

II. Improve the Efficiency of Securities Markets to Optimize the Allocation of Financial Resources A. Facilitate the development of corporate bond markets.

F.5. The government to (i) establish a debt capital market committee with broad industry participation to (a) identify constraints for corporate bond market development; and (b) formulate proposals to address these constraints, including measures to increase cost effectiveness and simplify corporate bond issues; and (ii) publicly disseminate the draft report of the committee

Complied with. On (i), in June 2006, the SECP formed the Debt Capital Market Committee comprising leading experts from the various industry stakeholders (issuers, investors, market participants, regulators, etc.) chaired by the chair of the SECP. The committee was asked to identifying the main critical issues hindering debt capital market development in Pakistan and make recommendations to address them. On (ii), the final report of the committee was disseminated through the SECP’s website in April 2007. http://www.secp.gov.pk/Reports/May_DebtCapitalMarketReport.pdf

F.6. The MOF and the SBP to take initial steps for building a benchmark yield curve for corporate bonds. Such benchmark yield curve to include yields of Treasury bills and Pakistan Investment Bonds by standardizing the terms of these instruments and issuing them at regular intervals

Complied with. Secondary market rates (the yield curve) for Treasury bills and Pakistan Investment Bonds (PIBs) are quoted by Reuters, starting from 1-week Treasury bill rates up to 30-year PIBs. The MOF and the SBP have standardized terms and issued PIBs with maturities of 3, 5, 10, 15, 20, and 30 years. Tenders for the sale are preannounced, as are target amounts and coupon rates.

S.6. The MOF and the SBP to maintain the benchmark yield curve and increase its liquidity over time by increasing the amounts of individual issues

Complied with. The benchmark yield curve has been maintained and its liquidity increased over time by increasing the amounts of individual issues. The auction calendar for issues is published on SBP’s website. http://www.sbp.org.pk/ecodata/index2.asp The rules for issuing government bills and bonds

http://www.sbp.org.pk/ecodata/index2.asp�

http://www.sbp.org.pk/ecodata/index2.asp�

Appendix 3

27

Policy Objective




Policy Action


with amounts and maturities to be determined by market conditions and government debt management policy

were changed for this purpose in January 2009. The SBP’s monetary policy statements make regular reference to the yield curve of government securities.

F.8. The SECP to remove regulatory constraints for corporate bond market development by (i) eliminating the regulatory requirement for public corporate bond issues to be listed on a licensed stock exchange; and (ii) introducing “shelf registration” procedures to allow corporate bond issues to be registered for at least 1 year, during which an issuer can issue bonds and raise funds efficiently during favorable market conditions

Complied with. Item (i): On 30 July 2007, the SECP decided to discontinue the regulatory requirement for the compulsory listing of corporate bonds on a stock exchange. The SECP has informed stock exchanges and market participants about this in writing (circular No. 2 as of 22 January 2008). Item (ii): The SECP’s guidelines for the issue of term finance certificates (bonds) were amended in 2006 to introduce shelf-registration (Chapter III, clause 10).

S.8. The government to (i) issue tradable government bonds through national saving centers and (ii) ensure a lower rate of return for National Savings Scheme instruments than for tradable government bonds

Complied with. The government introduced tradable retail bonds with maturities of 3, 5, and 10 years through the national savings centers in January 2010, after notifying regulation for the bonds in December 2009. The bonds are listed and traded at all three exchanges and transferable through the central depository system. The government prices National Savings Scheme instruments at 95% of the price for comparable Pakistan Investment Bonds.

28 A

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Policy Objective




Policy Action


B. Increase equity market breadth and reduce its volatility.

F.9. The government to (i) introduce a turnover tax on securities market transactions to reduce speculative trading by individuals, and (ii) extend the exemption from capital gains tax on income earned by individuals from investment in shares

Complied with. On item (i), a withholding tax of 0.01% on securities transaction at the stock exchanges was introduced through the Finance Bill 2006. On item (ii), through the Finance Bill 2007, the exemption from capital gains tax has been extended until June 2008. Since July 2010, capital gains are taxed, but only if the holding period is less than 12 months.

S.9. The Privatization Commission to (i) obtain approval of the Cabinet Committee on Privatization for a policy of supporting capital market development through the sequenced divestment of shares in state-owned companies through stock exchanges in both domestic and international markets, taking into account stock market conditions and investor demand; and (ii) publicly disclose this policy

Complied with. The 2000 Privatization Commission Ordinance allows privatization of SOEs, among other things, through public offering of shares through a stock exchange. On this basis, the Cabinet Committee on Privatization approved a policy of sequenced divestment of shares in SOEs through stock exchanges in domestic and international markets on 3 February 2011, and publicly disclosed this policy. http://www.privatisation.gov.pk/Capital%20Market/Capital%20Policy.htm

F.10. The government to sell a package of shares of at least one large state-owned company through listing on a stock exchange in an international financial center, and offer additional shares to domestic retail investors at a discount

Complied with. The Oil and Gas Development Corporation was listed at the London Stock Exchange in December 2006 when the Government of Pakistan divested an additional 10% of its shareholding in the company by issuing an equivalent amount of global depository receipts. The total capital raised was $934 million equivalent. 21,505,000 shares were offered at a discount to domestic individual investors and successfully placed in January 2007.

S.10. Upon the approval of the Cabinet Committee on Privatization on a case-by-case basis, the Privatization Commission to offer a specified portion of SOE shares through a book-building process in line with international best practices to domestic buyers with such shares being eligible for secondary market trading among such buyers for a specified period of time, and the SECP to allow the use of shelf-registration procedures

Partly complied with. Market conditions prevented the government from proceeding with SOE privatization. Among the few exceptions was the listing of 25% shareholding of United Bank Limited at the London Stock Exchange in July 2007 and the initial public offering of 7.5% of the shares of Habib Bank at the KSE in October 2007. Nevertheless, the SECP allowed shelf-registration (book-building) of shares in

http://www.privatisation.gov.pk/Capital%20Market/Capital%20Policy.htm�



Appendix 3

29

Policy Objective




Policy Action


April 2008, and all three stock exchanges revised their listing requirements accordingly in 2008. In 2009–2011, five private companies offered shares through shelf-registration: Ghani Gases, Fatima Fertilizer Company, Amtex, International Steels, and TPL Direct Insurance.

III. Strengthen the Governance of Capital Markets to Improve Market Transparency and Protect Investors A. Strengthen the institutional framework for sector supervision.

F.11. The SECP to (i) move to competitive levels of remuneration for senior officers, and (ii) designate specific positions for commissioners responsible for law, accountancy, and economic policy planning

Complied with. On (i), on 2 February 2007, following market research in 2006, the Policy Board of the SECP increased salary levels for commissioners, including the chair, by 50%, effective 1 January 2007. On (ii), SECP decided to establish offices of the commissioners responsible for law, accountancy, and economic policy planning. However, the positions were never advertized, because the SECP found it difficult to fill the existing five positions.

S.11. The MOF to consider and submit to the cabinet the draft FSCP law that strengthens overall regulatory governance, after stakeholder consultation and clearance by the Ministry of Law

Complied with. An FSCP law was drafted by the SECP with ADB support, but then renamed the SECP Act in 2010 to avoid the perception that the government is establishing an integrated financial sector regulator for nonbanking financial services and banking. The draft law was then submitted to the cabinet, cleared by Prime Minister on 10 June 2011 after clearance by the Ministry of Law, and submitted to Parliament.

F.12. The SECP to prepare and submit to the MOF a draft financial services commission of Pakistan (FSCP) law that strengthens overall

Complied with. The draft law, which was prepared with ADB technical assistance (TA), was submitted to the government (MOF) for approval on 30 March 2007. ADB reviewed the draft and provided the SECP with

S.12. The government to submit to Parliament for enactment the draft FSCP law as approved by the cabinet

Complied with. The secretariat of the National Assembly acknowledged the receipt of the draft FSCP law, which had been renamed the SECP law, on

30 A

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Policy Objective




Policy Action


regulatory governance by (i) establishing the SECP (FSCP) as the regulator and supervisor for, among other things, the nonbank financial sector and securities markets; (ii) providing a clear description of the powers and functions of the SECP (FSCP), including independent regulation-making authority (such as for issuing prudential regulations) and inspection, investigation, and enforcement powers; (iii) providing criteria for the appointment and dismissal of commissioners; (iv) providing legal protection to SECP (FSCP) staff where they are acting within the course of employment and in good faith; (v) clarifying the relationship between the Commission and the Policy Board, and defines the power of the Policy Board; and (vi) establishing an independent appellate tribunal.

comments. After incorporation of most of the comments, the draft law was resubmitted to the MOF on 30 July 2007. The ADB Office of the General Counsel has reviewed the draft and found that it complies with F.12.

10 June 2011. As of September 2012, the law is still before the Parliament’s Standing Committee on Finance.

Appendix 3

31

Policy Objective




Policy Action


F.13. The government to

establish a task force comprising the Central Board of Revenue, the SECP, and the Pakistan Business Council to (i) review the enabling environment for holding companies with special emphasis on their taxation, (ii) undertake stakeholder consultations, and (iii) formulate proposals in line with international best practice to facilitate the formation of holding companies

Complied with. A task force on the Review of Tax Laws of Holding Companies was established in August 2006 by the Central Board of Revenue. The task force comprised representatives of the Central Board of Revenue, the SECP, the Pakistan Business Council, and the Institute of Chartered Accountants of Pakistan. The task force has reviewed the enabling environment for holding companies in Pakistan and international best practice, undertaken stakeholder institutions, and presented its findings in a report that has been submitted to ADB.

S.13. The SECP (FSCP) to provide a legal and regulatory framework on the reporting requirements of holding companies, including (i) ownership structure and the relationship of companies within the holding company group, (ii) disclosure of intercompany and related party transactions, and (iii) public disclosure of audited financial reports in accordance with international accounting standards

Complied with. The SECP issued the Group Companies Registration Regulations, notified by Statutory Rules and Orders No. 1037(1)/2008 on 31 December 2008. These regulations provide the reporting framework for holding companies.

F.14. The government, based on proposals made by the task force, to facilitate the formation of holding companies by eliminating distortions caused by tax policies that may result in the double taxation of parent and subsidiary companies in a holding company network

Complied with. Through the Finance Bill 2007, a new section (59AA) has been included in the Income Ordinance that provides that holding companies and their subsidiaries may opt to be taxed as one fiscal unit. Another section (59B) now provides that the current year’s loss surrendered by the subsidiary shall be set off against holding company’s income in the tax year and the following two tax years (“group relief”). Both actions are key recommendations of the task force.

S.14. SECP (FSCP) to undertake a self-assessment to determine compliance with international best practices in the regulation and supervision of securities markets and private pension funds

Complied with. On 24 February 2010 SECP reestablished an interagency task force to undertake a self-assessment against the principles of the International Organization of Securities Commissions. The United States Securities and Exchange Commission provided support. The SECP also assessed its compliance with the principles of the International Organization of Pension Supervisors in 2009.

32 A

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Policy Action


B. Strengthen the governance of securities markets, market professionals, and public issuers.

F.15. The SECP to draft and submit to the MOF a new securities law that (i) replaces the 1969 Securities Ordinance; (ii) defines the concepts of and a private placement of securities, a publicly tradable company, a public offer of such company, so that all listed companies and unlisted publicly tradable companies are subject comparable governance, disclosure, and audit requirements; (iii) grants authority to the SECP (FSCP) to introduce “best efforts” and other levels of underwriting commitment; and (iv) grants authority to the SECP (FSCP) to require a national securities market system that will include one or more securities exchanges and, as necessary and appropriate, alternative trading platforms that provide for the public disclosure of customer purchase and sale orders to achieve best execution of customers’ orders.

Complied with. A draft securities law, prepared with ADB TA, was submitted to the MOF on 19 April 2007. The mission reviewed the draft and provided the SECP with comments. The SECP subsequently revised the draft law and resubmitted it to the MOF. The draft law meets the requirements outlined in F.15.

S.15. The MOF to consider and submit to the cabinet the securities law, as defined, after stakeholder consultation and clearance by the Ministry of Law

Complied with. The law, which was assessed by ADB as in line with international good practice, was submitted by the MOF to the cabinet in January 2010 after extensive stakeholder consultations and ultimate clearance through the Ministry of Law.

S.16. The government to submit to Parliament for enactment the draft securities law as approved by the cabinet

Complied with. The draft securities market law was submitted to Parliament on 28 June 2010. As of September 2012, the law is before Parliament’s Standing Committee on Finance.

S.17. The SECP (FSCP) to issue guidelines on obtaining information about unlisted publicly tradable companies (with stock exchanges continuing to provide disclosed information on listed companies)

Partly complied with. The SECP has drafted the guidelines based on the new securities law, shared them with the MOF, and submitted them to ADB. However, they can only be adopted after enactment of the new securities law.

S.18. The government to give the SECP (FSCP) the power to approve or disapprove audit firms authorized to audit financial institutions licensed or registered by the SECP (FSCP), listed companies, publicly tradable companies,

Complied with. The SECP was given the power to approve or disapprove audit firms by amendments to section 20 of the SECP Act 1997, which were passed by Parliament as part of the Finance Act in June 2008.

Appendix 3

33

Policy Objective




Policy Action


and financial holding companies that own or control one or more nonbank financial institutions

F.16. Industry stakeholders, with the support of the SECP, to complete a feasibility study for a certification agency (e.g., Securities Institute of Pakistan) to be established as a nongovernment body by industry associations and other private sector stakeholders for raising professional qualifications and standards of securities market professionals such as stockbrokers, investment analysts, fund managers, and sales agents

Complied with. The Karachi-based Center for International Private Enterprise launched a feasibility study for the Securities Institute of Pakistan in March 2007. After extensive and successful stakeholder consultations, the study was completed in May 2007 and submitted to ADB. The study foresees the establishment of the institute as a nongovernment institution by industry associations and other stakeholders for raising investor awareness and the professional qualifications and standards of market professionals.

S.19. The SECP (FSCP) to (i) develop a system of certification by examination for securities market professionals, and (ii) require all securities brokers and mutual fund sales agents dealing with public customers to be certified by a designated agency

Complied with. The Institute of Capital Markets (ICM) has been established by industry stakeholders under the guidance of the SECP as a nongovernment organization for training, examination, and certification of securities market professionals. http://www.icm.org.pk/ The ICM became operational in December 2009. SECP circulars 34 and 35 dated 30 October 2009 make certification mandatory for sales agents and brokers. The ICM now trains and certifies a broad range of securities market professionals, including brokers and sales agents. 66 brokers and 552 sales agents were trained by May 2012, of which 19 brokers and 335 sales agents were certified.

F.17. The SECP to provide partial financial support for the certification agency

Complied with. The SECP has included 20 million Pakistan rupees in its budget for 2007–2008 to support the Securities Institute of Pakistan.

S.20. The SECP to require all brokerage firms to designate a compliance officer certified by

Complied with. SECP circular 34 dated 30 October 2009 directed brokerage firms to

http://www.icm.org.pk/�

http://www.icm.org.pk/�

34 A

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Policy Objective




Policy Action


examination by a designated agency

designate a certified compliance officer to ensure effective compliance with relevant regulation.

F.18 To facilitate market transparency and best execution of customer orders, the SECP to require stock exchanges to establish an intermarket surveillance committee whose functions will be to (i) coordinate stock market surveillance, and (ii) carry out oversight of securities listed or traded on more than one exchange

Complied with. In June 2007, the SECP drafted terms of reference for an Inter Exchange Surveillance Committee (IESC) and discussed them with the exchanges. Subsequently, the IESC was established on 26 July 2007 to facilitate prompt, interactive, and effective decision making on surveillance issues. The IESC comprises the managing directors and heads of surveillance of all three exchanges and the following SECP officials: Commissioner Securities Market, Executive Director Securities Market Division, and the directors of the securities market divisions South (Karachi branch) and North.

S.21. The intermarket surveillance committee to meet and submit reports bimonthly or as otherwise deemed appropriate by the SECP (FSCP)

Complied with. Since its inception, the IESC has established itself well as a forum that facilitates prompt, interactive, and effective decision making on surveillance issues and improved coordination between stock exchanges.11 IESC meetings were held between June 2007 and September 2012. Minutes of meetings have been submitted to ADB.

F.19. The SECP to draft and disseminate on its website for stakeholder comments a new code of conduct for brokers to provide guidance on minimum standards for brokers in the following areas: duties of due care, skill, and diligence; adequate resources and procedures; information provided to and received from customers;

Complied with. A code has been drafted with ADB TA and was reviewed by the mission during fact-finding in March 2007. To facilitate stakeholder consultations, which are already ongoing, the SECP disclosed the draft code on its website on 30 July 2007.

S.22. The SECP (FSCP) to direct all stock exchanges to prepare and submit to the SECP (FSCP) a plan for consideration and approval on self-regulation, including (i) identification of functions to be performed and capacity needed to perform these functions; (ii) plans for each area (e.g., listed companies, market surveillance, and

Complied with. On 7 January 2008, the SECP directed the three stock exchanges to submit plans on self-regulation for SECP approval. The plans were required to cover the relevant areas identified by the International Organization of Securities Commissions’ consultative committee on self-regulatory organizations. The KSE submitted its plan

Appendix 3

35

Policy Objective




Policy Action


compliance with laws and regulations; clients’ assets; and senior management responsibility

on- and off-site supervision of professional market participants) in accordance with sound business practices and applicable laws and regulations, including the financial responsibility for, and the quality of execution of, trades on behalf of customers; and (iii) budget estimates of the cost of regulatory compliance

on 28 February 2008, and implemented measures to further strengthen self-regulation by December 2008. The other two exchanges (and the KSE) submitted plans in 2012 as a requirement to get regulatory clearance for demutualization, which took place in August 2012. The exchanges are now implementing these plans. The SECP can enforce implementation under the May 2012 demutualization act, which requires exchanges to separate commercial functions from regulatory functions.

S.23. The SECP (FSCP) to conduct public consultations on stock exchange rules and practices that constrain the exchange of information between stock exchanges (which leads to price distortion)

Complied with. All three stock exchanges conducted public consultations with members and clients. In 2007, LSE and ISE unified their trading systems. The unified system provides real-time information of prices at the KSE and other relevant information. This, together with the fact that a number of brokers operate at several exchanges, minimizes price distortions.

Documents

Completion Report - Asian Development Bank€¦ · Completion Report . Program Number: 41108 . Loan Number: 2340 . November 2012 . Pakistan: Second Generation of Capital Market Reform